Philadelphia

With a revamped real estate market, good times are ready for the city of brotherly love.

The Philadelphia commercial real estate market, which has lumbered through much of the decade in a depression due to overbuilding and a long-lingering economic recession, finally staged a strong rally this year. In some luxury office buildings in Center City and the Pennsylvania suburbs, rents soared to $29 per sq. ft. by midyear -- an all-time high -- where conversions of empty buildings to offices, apartments and hotels became trendy, and office vacancies fell to 4% in some areas.

"The factors driving the change lack the staying power. This year, the regional economy is in a growth spurt, while the supply of commercial space has remained somewhat constant," says J. Richard Jones, president and CEO of Jackson-Cross*Oncor International. "In the high and low cycles of real estate, the pendulum simply began to swing back. It's just part of the cycle. Real estate is obviously cyclical. If you trace back 50 years, you see these build, boom and bust cycles. We are right now at the end of the bust cycle and heading into a build cycle."

"Despite a recent flurry of development deals, there is no boom, just a long leap at the end of the bust cycle. In the Pennsylvania suburbs, much of the commercial land is getting snapped up and new construction is under way again," says Jones. "Build-to-suits are cropping up in areas in the western and northern suburbs where tenants can no longer find large blocks of space. New discount retailers such as Kohl's and Target have moved in. Community shopping centers, a darling for investors, are rising from the earth."

"I see it as a good solid market, it is solid almost across the board," says Walter D'Alessio, president and CEO of Legg Mason Real Estate Services. "The suburban office space and, interesting enough, the hotels are very strong. In retail, certain categories are doing well, though we got overbuilt in some areas. The northern and western suburbs are doing the best in office and retail. I think we are getting close to a peak in industrial and manufacturing, where the tightness of space has led to the healthy market. It is interesting to watch."

If you build it, they will come

Some of Center City's aging historic buildings are getting new leases on life as luxury apartments and elegant hotels. Annual rent hikes averaging 4.5% in Center City (6% to 8% in luxury buildings) and a 10-year partial tax abatement are fueling conversion of Class-B and -C office space into living space, while the expanding tourism industry is transforming aging highrises into top name hotels.

Downtown Philadelphia is not just the butt of jokes anymore. Increasingly, it is the place to visit and to live. "The population of Center City has grown substantially, from 40,000 in 1980 to 50,000 in 1990," says Carl Dranoff, president of the residential division of the Philadelphia-based Rubin Organization. "So the amount of people working downtown has gone up, and you have a greater number of short-term tenants, corporate executives, medical students and college administrators who are coming here for three to five years."

In June, the city council approved a 10-year partial tax abatement for developers who convert qualified historic buildings, which must be 50 years old and two-thirds empty. The Rubin Organization is finalizing plans to convert two buildings: an empty building at the corner of Broad and Chestnut in the heart of the Avenue of the Arts District, and a seven-story, 175,000 sq. ft. warehouse at 25th and Locust streets, which faces the Schuykill River. The two projects, which have a combined renovation cost of $48 million, will add 208 and 152 apartments respectively by 1999. The conversions are expected to begin this October.

"Philadelphia needs 2,000 new hotel rooms downtown by the year 2000 so it can compete for major conventions," says Mayor Edward G. Rendell. "Those gatherings would draw new retailers and restaurants, and open the gates for the waves of residents pouring into Center City apartments and driving up rents. The average adjusted rent in a one-bedroom, one-bath unit is now $850 a month."

Center City hotels sold more than 75% of their rooms last year, and revenues have soared to about $230 million in 1996, 53% higher than in 1994. For the past year, hotel developers have flocked to the city to explore the possibility of converting the abundance of vacant Class-B and Class-C office space into hotels. The financial puzzles all lacked one key element until recently and that was private investors. During this summer, the players coming in began to bring dollars into the game. The city's list of new projects includes a 369-room Westin Hotel by The Arden Group, a Westin Hotel & Resort at Two Mellon Plaza, and a 590-room Loew's Hotel in the old PSFS building developed by Rubin. Also, Marriott has a proposed 213-room hotel with a Hard Rock Cafe and 48,000 sq. ft. of retail space in Reading Terminal Headhouse, a $20 million renovation of the Hawthorn Suites Convention Center Hotel on Vine Street. With all the players moving into the final planning stages, more than 2,300 new rooms will be added to the downtown inventory.

Entertainment companies have not had one clear choice in Philadelphia, so they are scattered over tiny pockets such as upscale Walnut Street, youth-oriented South Street and Manayunk, a trendy area for young professionals.

"The pockets have never been big enough to support the influx of the major entertainment companies such as the Disney stores, Hard Rock Cafe, Planet Hollywood and so forth," says Martin Schiffman, managing director of Carl Marks & Co., a New York-based investment firm. "The waterfront is becoming the real entertainment venue in the city."

In May, the Simon DeBartolo Group signed a memorandum of understanding with the Penn's Landing Board of Directors and entered into a six-month period of exclusive negotiations to develop a nearly 600,000 sq. ft. urban entertainment center at Penn's Landing, a public park along the Delaware River. Within six months, DeBartolo expects to have the site analysis and a preliminary financing proposal prepared. The group has committed to finding the $100 million in financing; city and state funds will be limited to use on the infrastructure improvements, which are estimated at between $15 million and $30 million. Penn's Landing visionaries hope the attraction will blend the riverfronts in Philadelphia and Camden, N.J., into a seamless tourist destination, with museums, movie theaters, retail shops and restaurants that will draw from the estimated 100 million people who live within a 100-mile radius.

Just north of Penn's Landing, the views and visions are different. A Philadelphia-based development team led by Lance Silver and Partners, Stuart Harting and Affiliates and Carl Marks & Co. is drawing up plans for a 5.5-acre site that would include a 320,000 sq. ft. entertainment complex, a 500-room hotel and a World Trade Center with two office towers measuring 800,000 sq. ft. each. The retail project is estimated at $60 million, the hotel at $72 million and the office towers at over $400 million, respectively.

Where class still counts

In downtown Philadelphia, 1997 brought concrete proof the market was changing. Construction workers began to redevelop the first new construction project of the '90s.

The Rubin Organization Inc. is rebuilding Six Penn Center, a 406,000 sq. ft. complex with luxury offices, retail shops and a vertical parking garage. The company has signed Morgan, Lewis & Bockius, one of the city's largest law firms, as its only tenant. The central business district (CBD) has approximately 35 million sq. ft. of office space with nearly 16 million sq. ft. of it in Class-A buildings. According to Jackson-Cross*Oncor International, vacancy rates in Class-A buildings in Center City had fallen to 7% at midyear. Julien J. Studley Inc., a N.Y.-based real estate firm, notes strong leasing activity in the second quarter drove the overall vacancy rate down to 12.2% from 13.4%. Jackson-Cross puts the rate even lower, at 12.4%, and Jones expects the rate to fall to 10% or 11% by year's end.

"With the economy expanding once again, tenants in health care, financial services and in legal services were growing again. As the market has tightened, there has been a decline in the concessions offered by landlords, and rents in some prestige buildings have finally reached $28 per sq. ft., the level owners had anticipated when they built them," says Jones. "Very little sizable space remains in Class-A buildings, and it is that void that led Rubin to refurbish Six Penn Center for the expanding Morgan, Lewis & Bockius space."

"Improvement in the B- and C-class buildings has been slower, but the leasing pace is up over last year as space in Class-A product is now at a premium."

"Approximately 350,000 sq. ft. has been leased so far this year in Class-A buildings, down from 492,720 sq. ft. last year. In other buildings, more than 1.5 million sq. ft. was leased during the same period, up from 98,761 sq. ft. in 1996," says Julien J. Studley, president of the real estate firm. "There is one lingering dark cloud, the Bell Atlantic-NYNEX merger and the developments with Conrail could pour as much as 300,000 sq. ft. to 400,000 sq. ft. of Class -A space onto the recently firmed market, affecting future rates and concessions."

The West and the North rise again

Philadelphia's western and northern suburbs in Pennsylvania have been leading the Delaware Valley's recovery, and the pace of improvement quickened in 1997. Rents in pockets such as Conshohocken/Main Line, Bala Cynwyd and Chesterbrook are at all-time highs with vacancies under 5%. "At the end of the year, it was getting tighter in the suburbs," says Jones. "From January to June, the pace accelerated more rapidly than it did over the previous two years. Tenants don't have anywhere to go. They have fewer choices."

"Suburban companies are growing, and the market is along for the ride with the western and northern suburbs being the location for the high-growth businesses," says Bill Martin, managing director of Radnor Advisors. "As earnings continue to grow for these high-growth companies, you will see some new construction and continuing pressure on rents."

"Chester and Bucks counties are experiencing the most intense growth, in part because of the traffic congestion is not as bad as it is in other areas and rents are climbing steadily, up to $29 per sq. ft. in some buildings," says Jones. "Though new construction projects are being planned, the slow approval pace by the local governments is putting even further upward pressure on rents."

One emerging trend is the conversion of commercial properties into offices, as was the case with the 420,000 sq. ft. Hatboro building that had been empty since 1994. O'Neil Properties Inc. has announced plans to redevelop a similar project in North Wales.

The northern suburbs tightened as well, with occupancy rates reaching nearly 97% and rental rates averaging $17.58 per sq. ft. net of electric. In the Main Line and Conshohocken areas, the vacancy rates fell to under 6%. "Very small parcels of space are available and, in retail, the drug stores continued to fight for market share, corner by corner," says Tony Curcio, co-director of the retail division for Jackson-Cross. "The grocery stores are growing aggressively and the drug stores are more aggressive than they ever have been. They are going free-standing and now using drive-throughs."